“Stock Markets Should be Down Massively,” but Investors “Hypnotized that Nothing Can Go Wrong”

Bond bull Gundlach U-turns, goes “maximum negative” on Treasuries

Stock investors have entered a “world of uber complacency,” Jeffrey Gundlach, CEO of DoubleLine Capital in Los Angeles, explained – we assume with some bafflement.

On Friday, the S&P 500 hit another all-time high, after it was reported that the US economy grew at a painfully slow rate of 1.2% annualized in the second quarter, after a first quarter of 0.8% growth, which produced a first-half growth of 0.9% annualized, the worst in four years.

Even “adjusted” ex-bad-items earnings of S&P 500 companies have declined on a year-over-year basis for four quarters in a row. Total business sales in the US have declined since mid-2014. Defaults of companies rated by Standard & Poor’s have jumped to the highest level since the Financial Crisis. Overall business bankruptcies are soaring. Yet, stocks march higher.

“The stock markets should be down massively, but investors seem to have been hypnotized that nothing can go wrong,” he said.

And his firm went “maximum negative” on Treasuries on July 6, he said. That day, the 10-year Treasury yield fell to 1.32%, taking out the low of 2012. “We never short in our mainline strategies,” he added. “We also never go to zero Treasuries. We went to lower weightings and change the duration.”

On Friday, the 10-year yield was at 1.45%. So at the moment, his timing was right. Money was being lost in Treasuries; prices fall as yields rise.

Gundlach’s “maximum negative” on Treasuries is a U-turn. For years, he’d been out there telling astonished listeners that yields would fall further from their already ludicrously low levels.

For example, on January 14, 2014, he shocked Wall Street and the media when he predicted that the 10-year Treasury yield would fall as low as 2.5% in the near-term. It was a ridiculous prediction. At the time, the 10-year yield was at around 3.0%, and Wall Street predicted that it would climb to 3.4%.

By mid-May, 2014, the yield hit 2.5%.

Then on December 9, 2014, he went way out on a limb and predicted that 10-year Treasuries would gain even more in 2015, and that the 10-year yield could plunge as low as 1%.

“Why not?” he told Reuters at the time. “The European rates are at 1%. France is below 1% right now,” he said. People laughed at him. QE Infinity had ended. The Fed had begun flip-flopping about rate increases. At the time, the 10-year yield was around 2.2% and couldn’t possibly go lower.

“If oil goes to $40, something is very wrong with the world,” he said in the same interview. Nonsense, people said. Oil will never drop this far.

In January 2016, WTI fell below $30 a barrel! The 10-year Treasury yield hasn’t quite made it to 1%, but got close: On July 6, 2016, it fell to 1.36%.

That was the day he turned “maximum negative” on Treasuries, which should give Treasury bulls the chills.

“The yield on the 10-year may reverse and go lower again, but I am not interested,” he said. “You don’t make any money. The risk-reward is horrific,” he said. “There is no upside” in Treasury prices.

But it’s not just stocks and Treasuries that are in for a haircut. Gundlach pointed out that, as Reuters put it, “many asset classes look frothy,” though DoubleLine continues to hold gold, which he predicted will reach $1,400 (from $1,349 on Friday). And it continues to hold gold-miners.

Which shows how subverted the theory of stocks, bonds, and “safe havens” has become. Central-bank market manipulations have inflated the safe havens to absurd levels, and they’re no longer “safe” havens. About $13 trillion of government bonds globally have negative yields, and some corporate bonds are hovering nearby. Investors used to buy them to get income. Now they buy them in the hope of even more negative rates so that they can sell the bonds and benefit from capital gains, because holding these “safe-haven” bonds to maturity produces no income but is associated with guaranteed losses.

And those investors that need income and that used to look for it in “safe” bonds pile into junk bonds to get this income, hoping fervently that these junk bonds won’t default, which they have started to do. And they pile into stocks for dividend income, hoping fervently that this dividend income won’t be slashed or eliminated, which is what happens in every downturn, in which case the stock would plunge and the yield would disappear.

With regards to these central bank machinations and manipulations around the world, Gundlach added another nugget. The Bank of Japan’s refusal on Friday to sink interest rates deeper into the negative is an acknowledgement of the limitations of monetary policy, he said, adding: “You can’t save your economy by destroying your financial system.”

presumably, william. i think the goal is to increase indebtedness such that the available cash can be consolidated from the borrowers.

the introduction of negative interest rates should, in theory, cast a ‘wider net’ of individuals, thereby increasing the number of borrowers (people) in the pool. by doing so, the theory (i assume) is that the lender can “collect” cash from these new borrowers (via payments), thereby reducing overall borrowers’ cash supply (the only other source of cash aside from the lender). ideally, i assume, each borrower wants every individual in their jurisdiction to be indebted to them so the “cash” can be consolidated.

however i think this theory is flawed because there is some implicit assumption that there is only one CB-ish lender (there may be, but not at an institutional level), which means every bank performing the NIRP experiment must have some expectation that it will result in holding everyone’s debt, and thus control the cash supply.

given the increasing number of banks carrying out this policy independently, there are more “moving parts” that invariably impede consolidation of pool of borrowers, especially outside of the BoJ ECB etc.

imo the larger problem is, and as was touched on an earlier post about Apple issuing debt in the states to take advantage of low interest, althewhile holding “cash” offshore, is that the concept of cash and credit have been muddled.

i think someone argued that this strategy is merely “reducing tax burden” and is “smart”, but i disagree. each country’s consumer has a different levels of immediately-available bartering currency (definition of cash), and the distribution of such a desirable bartering mechanism often depends on the status of the nation itself.
-this idea is furthered when you realise that much of apple’s billions “cash” is a result of credit purchases from both third and first world countries, where the former are impoverished and the latter (near) maximally-indebted.

consolidation of total credit purchases, followed by moving this total offshore (minus some fee) does not make it “cash” because credit is being used as recessionary rescue mechanism.
-the whole point of using credit as a recessionary rescue mechanism was the idea that “no money is being spent” to stimulate, again, credit is speculative.

it was hoped that by using credit for ~5-6 years, that the credit used to “jumpstart” the economy would eventually be paid off through productivity (labour), and things would be smiley. however, the distribution of this cash-disguised-as-credit is/was sucked up by “big players” (leveraged buyout losers), which greatly impeded the execution of this idea.

both india and china’s consumption (iphones etc) are a good example of how increased credit availability, even for a few hundred dollars, can cause distortions in high population markets because the “risk profile” is reflected by the small limit, and yet little recourse is available in case of default thus, much of the “cash” held offshore is actually originated from credit, and not cash at all.

thus, the system as it is currently operating is (either intentionally or not) viewing “cash” as the same as credit, which is nothing short of a disaster.

even if you were to subtract the few pct merchant fee associated with every credit purchase, and add it up over billions of sales, the merchant is still indifferent between credit and cash (in most settings) because the availability of the former, and creation of the latter from the former, has resulted in indifference (which is not good. cash should *always* be the most desired payment)

the issue is that too much “cash” has been created from credit (a speculative mechanism) without a sufficiently-extreme mechanism to protect the former from turning into the latter.

all original research and i’m not an “economist”, but i do have substantial math experience (no financial math though. don’t believe in it), so i may be blowing chunks. just wanted to share my perspective on the matter.

Petunia

Aug 1, 2016 at 9:49 am

NIRP is basically a wealth transfer from savers to spenders. Whether it contracts or expands the money supply is dependent on what the banks do with the money they confiscate. If the money is lent out, it is expansionary at a higher multiple than if they spend it on expenses, which is also expansionary but less so. If the money sits as capital it is contractionary, as it is when it sits unlent in an interest bearing depositor account.

Petunia

Aug 1, 2016 at 9:51 am

This was response to Will.

Mike R.

Jul 31, 2016 at 3:09 pm

Two thoughts:
1) I belive, but obviously can’t prove, that the US government at the highest levels is ensuring the stock market stays UP. This is likely done through the big banks such as GS and JPM buying stock futures as well as an established expectation that major corps buy up their stock. They are also manipulating gold down and oil up as well as other financial parameters…..to the degree they can based on overall fundamentals.

The government could not hold up the markets in a major selloff that was spawned by fear. In that case, they would do what was clearly done in 2009; after the selling washed out, they would start buying the market back up. Low volume, prices set on the margin and up she comes. Pretty easy really.

2) Negative interest rates does indeed reduce the money supply; however, the money supply is so overinflated at this juncture that it is insignificant. In a big picture sense, negative interest rates means that there is too much money chasing too few investment options. Inflationary policies have grossly overrun real world investment needs.

Jungle Jim

Jul 31, 2016 at 3:48 pm

The thing that I find most worrisome is that the central bankers the world around don’t seem to learn from their own mistakes. They have been manipulating their economies for years by creating mountains of debt, and all they’ve actually managed to do is to create asset price inflation. They claim to be creating “wealth effect” yet yet the real economies deteriorate. Either the central bankers are very, very stupid, or they are lying about what they are trying to do.

Chicken

Jul 31, 2016 at 4:25 pm

Central bankers are well paid for their expert opinion and hard work but not by you and me. It has never been revealed officially, whom their real employers are, and they seek to keep it that way.

Mary

Aug 1, 2016 at 9:09 am

It’s the Freemasons. In league with the Illuminati.

Petunia

Aug 1, 2016 at 9:53 am

It’s worse. They do whatever they want.

EVENT HORIZON

Aug 1, 2016 at 2:08 pm

They are not stupid.,

They are very, very intelligent.

IT is we who are stupid.

TonyL

Jul 31, 2016 at 4:54 pm

1. Negative rates are an effect of monetary policies, not a cause. They cannot diminish the money supply. The are intended to stimulate banks to lend rather than hoard.
2. Central banks are carrying the burden of salvaging an economy that governments seem to be unable/unwilling to tackle. Governments are the bad guys. Central bankers simply cannot deliver what they were never designed to deliver.
3. Given the bankers’ mandate to steer away from inflation yet stimulate the economy the result is that their current actions are causing a significant asset inflation. One of the side effects is inflation of housing prices and that might soon give rise to a more general CPI inflation.
What is worrisome is that all this has happened before and went unheeded.
Gundlach might be right about gold.

Tony, asset price inflation is NOT a “side effect.” It was the primary GOAL of the Fed. It called this the Wealth Effect. Bernanke spelled it out in an editorial in 2010:

“Strong and creative measures” is what he called QE and ZIRP

“And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

I have to agree with Mr. Gundlach as well, and have sold my closed-end Muni Bond ETFs, and half of my stocks (which is a bit frustrating as the markets march higher). For what it’s worth, I am 65% cash, 25% dividend paying equities and 10% betting against the S&P 500 with SH.

Holding cash straight up doesn’t pay anything back, but as the dollar continues to strengthen, it is about the safest way to protect one’s capital. If the CBs do not keep NIRP and ZIRP going ad infinitum, the value of bonds could get sliced up in a very short time. Municipal pension funds in the US are also backed against the wall, and I think defaults are just around the corner.

Good luck to all WS readers who’re trying to invest and protect themselves in this crazy time where the Fed gives Wall Street “Money for nothing” a la Dire Straits.

Semper Gumby

Aug 1, 2016 at 4:58 pm

Thank you John,

Wonderful presentation in which I learned a lot. Not the whole story. There are significant portions left out but taught me a lot. Stories in the MSM are starting to make sense i.e. Koch Brothers not backing Trump. Thanks.

interesting

Aug 1, 2016 at 1:20 pm

“And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Higher incomes? WTF 80% of Americans (those folks who’s well paying jobs are now done in China) don’t own stocks in a manner that would give them “higher income” to increase spending. This is insanity, the only thing that is going to increase spending is increased earned income, sadly that horse left the barn decades ago as did taking on more debt to maintain a certain lifestyle.

The only way out of this mess are jobs that pay a wage that affords an American lifestyle. There is no other way.

Some of us have been in recession since Q3 2014 and it’s not getting any better.

Yes, you need to make sure Bernanke and now Yellen read this. But they won’t. They’re immune to logic.

Smingles

Aug 3, 2016 at 12:15 pm

“The only way out of this mess are jobs that pay a wage that affords an American lifestyle. There is no other way.”

Therein lies the problem, though. Where are those jobs going to come from?

Even if you cut trade agreements and forced manufacturing to come back to the US, how will a company that has been accustomed to paying laborers $1 a day adjust to paying American labor $12 a day (or whatever number you think qualifies as supporting an “American lifestyle”), plus benefits…?

It’s not going to happen, at least on any scale significant enough to matter. There are two options: cheap labor overseas, or automation. Neither helps the American worker.

The sooner people rid themselves of the delusion that America can be brought back to some 1950s-style utopia where John Doe can support a family with his 40-hours at the auto plant, the sooner people can begin figuring out real long term solutions.

John Doyle

Aug 3, 2016 at 8:37 pm

Since the private sector is not creating enough jobs, them it has to be the federal government to step up to the plate. There are always jobs available which a government can plan for, even repairing infrastructure will boost GDP and may be a big saving in other costs, such as the saving in having reduced traffic snarls and pollution costs. Only the federal government can do such things as many are not profitable for private sector interests.
The costs come back to government which can create the funds and net credit the customer accounts via the reserve accounts that commercial banks keep at the Fed. The economy gets a boost.

Arbuthnot

Jul 31, 2016 at 5:06 pm

The primary role of the professional academic is the acquisition and dissemination of knowledge. Noble objectives. To achieve these lofty goals he seeks the security of the ivory tower where missteps are considered acceptable risks. But when he leaves the tower and is recruited for his knowledge by business or government, problems tend to crop up. If knowledge is his stock in trade, how can possibly admit it when he is wrong? He was hired to be right, to have the answers that mere mortals need but can not find.

Today many central bankers come from academia and have advanced degrees. So of course they should know the score , but sometimes they don’t and when that happens, admission of failure tantamount to self destruction.

Since ancient times, “wise” men have been called upon to predict the future. “Is now a good time to attack my enemy, to run for office, to take on more risk” and so on. When the advice was not good, the advisor often paid a heavy price. But today that very effective cleansing mechanism is no more or so it seems. Instead we must pay the price while the “wise” man accepts no blame, retires and is rewarded with outrageous speaking fees and perhaps a book contract that runs into seven figures.

Not right? Hmmm… And we have no one to blame but ourselves.

Petunia

Jul 31, 2016 at 5:51 pm

I take exception to the idea that academia is pushing their ideologies on business or govt. Wall St. hires PHDs to produce the research and outcomes they desire. All research is curated in their favor, as well as, produced on demand.

Chip Javert

Jul 31, 2016 at 6:20 pm

Arbuthnot

A lot of those wise men and academic institutions have spent considerable effort to convince the rest of us that the science of economics can enlighten the path to happiness.

Problem is, economics is not a science. It’s an observational activity (sorta like psychology). While there are fundamental principles (supply and demand), there are no fundamental laws of economics. Einstein’s relativity is a fundamental law – it applies to absolutely everything all the time. Any econ college freshman can point out a dizzying array of material violations of the “law of supply and demand” – iPhones are one – for a number of years their demand was fairly resistant to lower priced & better featured supplies of cellphones.

To get around this, economics uses the concept of a “rational individual” who makes financial decisions according to fundamental economic principles (not laws). Quite frequently humans in the real world do not act like “rational individuals”. For example: in war, when they’re scared, when they’re emotional, when their ego gets involved.

Times of great economic stress (like what happened in Greece) are perfect examples of when the general principles of economics can break down. Of course Greeks know they can’t afford their pensions, but they’ll starve without them.

Uncle Frank

Jul 31, 2016 at 5:26 pm

“Equity investors are following their counterparts in the bond world in starting to think that maybe it really is different this time.”

Rates are headed down and govt spending going up. The trump effect is sending a. Strong message to govt….start making jobs and spending more money.

Eyes Wide Shut

Jul 31, 2016 at 8:46 pm

Appreciate your great articles but I don’t think investors are pushing this higher. Probably Fed and manipulators.

mike gunderson

Jul 31, 2016 at 9:07 pm

one should check out Gundlach’s hedge funds. They are not doing very well. So he wants to paint a gloomy picture to deflect criticism of his poor investments!

chris Hauser

Jul 31, 2016 at 9:54 pm

might be so, but i am not loaning money to the us government at 1.5% for ten years. my mother would disapprove.

but i’d like to borrow more at 3.5% for 30 years, yes i would.

which after the tax deductibility and depreciation, comes out to about 1.5%, hey, i’ve moved up in the world, i’m a sovereign too.

AC

Jul 31, 2016 at 10:57 pm

I was going to invest in equities, but HFT algorithms mugged me outside the exchange.

ERG

Aug 1, 2016 at 7:33 am

Economics is a ‘science’ in the same way Olympic figure skating is a ‘sport’: results are a matter of opinion.

r cohn

Aug 1, 2016 at 10:05 am

Interest rates have ONE primary purpose ,i.e. to encourage investment by lowering the cost to borrow.More investment will result in more productivity.

But what has really happened ?Western governments and Japan are approaching a period of rapidly expanding entitlement spending for the elderly. This added spending along with wasteful military spending will be the drivers of even larger deficits in coming years.Is this added spending,funded by ultra low interest rates, going to make an economy more productive.
Corporations are taking advantage of these low interest rates by borrowing money to buy back stock and fund dividends..Does these actions make an economy more productive.
Unless interest rates,NO MATTER WHAT THE LEVEL,result in more investment which in turn results in more productivity,they cease to be positive factor in the economy.

ML

Aug 1, 2016 at 4:45 pm

Interest rates have another purpose. To attract savers to lend their money to the banks. But the banks can borrow more monet and also more cheaply from the wholesale money markets and quantative easing. So the only reason for savers to deposit cash with the banks is for safe- keeping. Naturally, the banks charge for the priviledge.

Stock market seems over valuated in recent years and a correction might be on the cards in coming years.

The Dutchman

Aug 6, 2016 at 10:39 am

Systemic risk from the Emperors’ subjects seeing NIRP and ZIRP being clothless? Not to worry. God gave me five fingers on each hand. It is kind of a stretch now using both hands but I still have one finger left on my second hand. Systemic risk??? A tidal wave coming? Not to worry!